Conflict of interest: When the insured has the right to select independent counsel

When an insurance carrier agrees to defend its policyholder in a lawsuit, the general rule is that the carrier has the right to pick the lawyers and control the defense, so long as it has agreed to defend the suit unconditionally. But when the carrier agrees to defend the lawsuit while simultaneously reserving its right to deny coverage at a later date, this rule changes and the policyholder may have the right to select its own independent counsel.

Because the insurer and the insured both may have good reasons for wanting to control the defense, this frequently becomes a point of contention. However, policyholders should use caution before rejecting a defense offered under a reservation of rights because the circumstances in which the carrier loses control of the defense vary considerably from state to state.

Insurers have plenty of reasons to want to select defense counsel. When a carrier is potentially liable for a judgment against its insured, it naturally will want to ensure that the defense counsel is competent to handle the case. Insurers also use the right to choose counsel as a means to control costs, retaining lower-priced firms or firms that agree to work at reduced rates in exchange for repeat business from the carrier. Policyholders also may have strong incentives to choose the counsel. The policyholder may have a long-standing relationship with a particular outside law firm, or it may wish to use a firm that has already been advising it on issues related to the lawsuit.

Where the insurance carrier agrees to defend unconditionally, the interests of insurer and insured are theoretically aligned: each wants to defeat the claim against the insured. However, when the carrier’s defense is offered under a reservation of rights, a potential conflict of interest arises, which in some cases precludes the insurer from controlling the defense. Courts in different states have taken divergent views on when such a conflict arises. In some states, an insurer’s reservation of rights, in and of itself, creates a sufficient conflict of interest to justify the insured’s choice of defense counsel. In other jurisdictions, the policyholder is not allowed to choose independent counsel unless the insurer reserves its rights based on an issue that will also be litigated in the underlying action. Most courts find that such a conflict of interest precludes the insurer from choosing counsel or controlling the defense. However, courts in at least one state have held that, where there is a conflict of interest, the insurer retains the right to choose “independent” counsel so long as it does not actively control the defense.

The patchwork of rules can be confusing, and a policyholder must be aware of the local standards before it rejects defense counsel offered by its insurance carrier, as two recent cases demonstrate. In Quality Concrete Corp. v. Travelers Property Casualty Co. of America, an insured notified its carrier of a claim after receiving an “adverse communication” from a third party. The carrier hired a law firm to defend the potential lawsuit and informed the policyholder that it reserved the right to deny coverage for any punitive damages that might be awarded. The policyholder hired its own counsel and, after settling the case, sued the carrier to recover its counsel fees. The Rhode Island Supreme Court held that the insurer’s reservation of rights did not create a true conflict of interest allowing the insured to choose counsel, because the case settled before the claimant ever filed a complaint, and therefore the claimant never sought punitive damages, the basis for the reservation of rights.

Similarly, in Downhole Navigator, L.L.C. v. Nautilus Insurance Co., the 5th Circuit, applying Texas law, held that an insurer did not have to reimburse the independent counsel fees of its insured when the grounds for its reservation of rights did not implicate facts that would be adjudicated in the underlying action.

When an insurer agrees to defend under a reservation of rights, the policyholder should always consider whether it would be better served by retaining its own counsel to defend the lawsuit rather than accepting counsel offered by the insurance carrier. However, before making any decisions in this regard, policyholders ought to acquaint themselves with the applicable law of their jurisdiction.

Contributing Author

Richard Milone

Richard D. Milone is the Chair of Kelley Drye & Warren LLP’s Insurance Recovery practice, which has attorneys in Washington, D.C., New York and Los...